Socializing Risk: The New Energy Economics

Despite talk of a moratorium, the Interior Department’s Minerals and Management Service is still granting waivers from environmental review for oil drilling in the Gulf of Mexico, including wells in very deep water. Until last month, most of us never thought about the risk that one of those huge offshore rigs would explode in flames and then sink, causing oil to gush out uncontrollably and befoul the oceans. The odds seemed low, and still do: Aren’t there lots of drilling rigs in use, year after year? Twenty years ago, your elected representatives thought that you’d be happy to have them adopt a very low cap on industry’s liability for oil spill damages.

Nuclear power was never quite free of fears; it was too clearly a spin-off of nuclear weapons to ignore the risk of a very big bang. Yet as its advocates point out, we have had hundreds of reactor-years of experience, with only a few accidents. (And someday when Nevada’s politicians aren’t looking, maybe we can slip all of our nuclear waste into a cave in the desert.) Again, the risks are so low that you’d be happy to learn about a law limiting industry’s liability for accidents, wouldn’t you?

Environmentalists have long warned that the world could run out of energy and resources, from the “limits to growth” theories of the 1970s to the more recently popular notion of “peak oil.” The response from economists has been that prices for energy and raw materials are still moderate, and declined over the course of the 20th century; if we are running out of something, why doesn’t its price skyrocket?

The problem is that what we’re running out of is low-risk conventional energy supplies. Because our economy conceals and socializes energy risks, prices remain deceptively low for an increasingly risky energy supply.

The market wasn’t supposed to work this way. In the mythology of perfect competition, each individual business bears the entire risks of failure as well as reaping the rewards of success. Almost all small businesses quickly fail, a point which is glossed over in the cheerleading for competition – but the damage is normally limited to the loss of savings and derailing of careers for the unlucky proprietors.

This model of competition and individual risk-bearing may be a great way to decide which restaurants should stay in business. For offshore oil rigs and nuclear reactors, it’s not so good. The risks are enormous, potentially affecting large numbers of innocent bystanders. The costs of these energy technologies are high enough that large companies are the only candidates for using them. And large companies don’t like to bet the existence of the company on uncertain risks from dangerous technologies. Most large companies don’t fail, ever; they do everything they can to avoid bet-the-company risks.

That’s where Congress has stepped in, to socialize the risks of energy supply. The Oil Pollution Act of 1990, adopted in the wake of the Exxon Valdez accident, imposes a tiny tax on the oil industry, currently 8 cents per barrel, to finance the Oil Spill Liability Trust Fund, which now contains $1.6 billion. In exchange for the tax, the Oil Pollution Act limits industry liability for spills to actual clean-up costs plus $75 million. That amount is a pittance for a giant oil company, and is far below the economic losses to the communities affected by BP’s recent spill in the Gulf of Mexico. While BP has said it will voluntarily pay more, U.S. law does not require it, and BP shareholders might not tolerate it.

No utility would ever invest in any reactor without the Price-Anderson Act, which puts a strict upper limit on industry’s liability for a nuclear accident. The limit is now up to about $10 billion (to be shared by the industry as a whole), higher than for oil spills but still far below the damages that could be caused by an accident at a reactor, especially one close to a major city. The federal government has, in addition, guaranteed that it will find a final resting place for nuclear waste from reactors around the country, although Yucca Mountain, the only site seriously debated in the first few decades of discussion, has apparently been rejected.

That’s why risky energy technologies look cheap: Congress has decided that we, the taxpayers, are the industry’s insurance policy. Unlike insurance companies that know what they’re doing, though, Congress doesn’t bother to calculate the real risks and set premiums on that basis. Instead, they pretend that the worst will never happen; happy days and low prices are here again, and again.

We are in danger of applying the same short-sighted approach to the biggest energy risk of all, namely climate change. Pretending that the worst case couldn’t possibly happen is all-important to those who want to go slow on climate policy; the most likely climate outcomes for this century are unpleasant and expensive, while the worst cases are truly catastrophic – and too large and irreversible for anyone to pay for the damages. But not to worry: Those catastrophes are at least as unlikely as an oil rig capsizing and filling the Gulf of Mexico with petroleum.

Share this:

It seems fairly clear that traditional macroeconomics and cost benefit analysis are wholly inadequate tools to address the issue of risk of disastrous events, either at local levels or globally, like climate change. In the face of the dwindling of conventional oil reserves, neo-classical economics says “no problem, there are still loads of unconventional reserves, and higher prices will drive extraction there”, without of course taking into account that the financial and energy inputs for extraction will rise, and more importantly, the risk of local and global environmental disasters will rise. You need look no further than the fact that the extraction of the tar sands is justified on the basis that it is preferable to extra-heavy crude in Venezuela or elsewhere, when the real issue is that we should be building an economy that simply does not depend on taking such risks. At Due South (http://www.iied.org/sustainable-markets/blog/due-south) we´re looking at the implications of the Gulf of Mexico disaster, particularly in developing countries, so check us out if you´re interested!

Humans have always “socialized” risks, but frequently not rewards. The main issue we face now is that the risks we have made for ourselves have far outpace the means we have to address these risks and their costs. We have put all or most of our energy bets on one square on the table, the fossil fuels square. And then we proceded to increase the demand for these fuels to the point of breaking the arrangements and devices we created to supply this demand. In this situation the risks cannot either be reasonably estimated or mitigated. In simple terms we have stressed the physical, economic, and organizational design for energy resource discovery, production, and delivery to the point of collapse. Then we are astonished when collapses occur. We must reduce the stress by setting up alternatives to the fossil fuels, reducing both fossil fuel and overall energy demand, and improving the physical, economic, and organizational technologies we use for energy discovery, production, and delivery. Don’t know how much time we have to get this done, but it’s not much. Perhaps one or two decades.

So – I note its called “socialising the risks” however everyone assumes that government is operating in the public interest, free of interference, bribery and corruption. If that is the case why is the repair fund only a little over 75 mill for an oil spill of this massive magnitude. It couldnt possibly be because someone (at some stage) was bribed and induced or cajoled to agree to a such a paltry recompense from firms that cause massive environmental damage could it?

I have given up all hope that governments are not corrupt to the top in the US and in most industrialised nations…and perhaps the sooner we accept this glaring fact, the better off we will all be (if only to be resigned to ongoing wrongs and incompetencies and the abject failure of governments to even be able to implement sound policies).

In this case we need a mechanism that allows for the company to internalize the risk. We had attempted to do so in the oil drilling industry before by means of fines if certain safety standards were not met, however clearly these fines were not large enough as BP continuously failed to meet those standards and paid a significant amount in fines. It seems clear to me that if fines had been large enough to effect BP’s incentives, we might had been able to avoid this catastrophe. The ideal fine would be at the point at which:

Agree karen
– its like the fines for insider trading – so much less than the profits from insider trading that they may as well be a parking ticket offence.
In such cases the government is nothing more that the mouse that roared.

Email subscription to this blog

RWER 26,498 subscribers

Real World Economics Review

The RWER is a free open-access journal, but with access to the current issue restricted to its 26,498 subscribers (07/12/16). Subscriptions are free. Over one million full-text copies of RWER papers are downloaded per year.

—- Forthcoming WEA Paperbacks —-

———— Armando Ochangco ———-

Shimshon Bichler / Jonathan Nitzan

————— Mauro Gallegati ————–

————— Herman Daly —————-

————— Asad Zaman —————

—————– C. T. Kurien —————

————— Robert Locke —————-

Guidelines for Comments

• This blog is renowned for its high level of comment discussion. These guidelines exist to further that reputation.
• Engage with the arguments of the post and of your fellow discussants.
• Try not to flood discussion threads with only your comments.
• Do not post slight variations of the same comment under multiple posts.
• Show your fellow discussants the same courtesy you would if you were sitting around a table with them.